Income Effects don't really exist

I'm an expert on how non-economists think. That's because every year I try to teach 300 non-economists to think like economists.

Non-economists think in terms of income effects. Economists think in terms of substitution effects. That's a stereotype that isn't 100% true, but it still contains a lot of truth.

Here's how non-economists think:

1. Why does the demand curve for apples slope down? "Because if the price of apples rises, people can't afford as many apples."

2. Why does the Aggregate Demand curve slope down? "Same as apples. Because if the price of everything rises, people can't afford as much of everything."

3. Why is inflation bad? "Same as AD. Because if the price of everything rises, people can't afford as much stuff. Duh."

4. Why does the labour supply curve slope up? "It doesn't. It slopes down. If real wages fall people have to work longer so they can still afford to buy stuff."

5. What is the effect of an increase in interest rates on demand? "If interest rates go up, people can't afford to borrow as much and spend as much, so demand falls." (Except for a few much older students, who argue "If interest rates go up, we get more income, and can afford to buy more.")

What's wrong with thinking like this? OK, they missed out the substitution effects, and so ignored the fact that when the price of apples rises relative to other goods, people substitute away from apples and into other goods. But they still got it half right, didn't they?

No. They got it wrong.

Let's start with apples. For every apple bought there's an apple sold. If the price rises by $1, the buyer is $1 poorer, but the seller is $1 richer. Sure, there are many more buyers of apples than there are sellers of apples. But so what? If 1,000 buyers buy 1 apple each from one seller, there are 1,000 buyers each $1 poorer and one seller $1,000 richer. Even if we assume apples are a normal good ("normal" means you buy more as your income rises), there is no way of knowing what the total income effect will be. Each buyer is a tiny bit better off, and will want to consume a tiny amount more apples. But the seller is a lot worse off, and will want to consume a lot fewer apples. Total desired consumption could go up or down, depending on whether the buyers or sellers of apples have the higher income elasticity of demand for apples. It all depends on whether the buyers or sellers have a greater propensity to spend any extra income on apples.

(There are two ways to treat the apple seller's own demand for apples: we can subtract it from the supply curve; or we can add it to the demand curve. You get the same results either way, if you are careful. But it's a lot easier if you add it to the demand curve, because that way the supply curve doesn't depend on the seller's own preferences for consuming apples.)

The thing that caused the price of apples to increase might have an income effect. A late frost, which reduces total apple production, makes total real income lower. If the frost destroys 1,000 apples, worth $1 each, the apple seller is $1,000 poorer at the existing price of apples. But the price increase itself has zero effect on total real income. It merely redistributes income from buyers to sellers.

In aggregate, price changes do not have income effects. They have distribution effects. We can talk about the income effects of price changes at the individual level, once we know whether the individual is a buyer or a seller. At the aggregate level, looking at the market demand curve for apples, we can only talk about distribution effects. And substitution effects, of course.

If all apples were imported, it would be different. The Canadian demand curve for apples would have an income effect. We have excluded all sellers. But it would be different again if some apples were exported. An increase in the price of apples would now increase Canadian real incomes, and the income effect would tend to increase the quantity of apples demanded by Canadians.

The way non-economists think about the demand curve for apples doesn't just leave out the substitution effect. It's just plain wrong. It is simply not true to say that if the price of apples rises we can't afford to consume as many apples. That "we" ignores the seller of apples. If the "we" includes both buyers and sellers, then collectively we can afford to consume exactly the same amount of apples as before.

What works for apples works for everything else. For every apple bought there's an apple sold. For every unit of GDP bought there's a unit of GDP sold. For every $1 borrowed there's $1 lent. For every hour of labour sold there's an hour of labour bought. At the aggregate level, there are no income effects of changes in prices, interest rates, wages, etc. There are only distribution effects. And substitution effects.

We know that substitution effects are negative. That's why demand curves slope down and supply curves slope up. We need a lot more information to tell which way distribution effects will go. They might be negative, or positive, or zero. One of my own teachers once said "Distribution effects are the last refuge of a charlatan". I wouldn't go quite that far, because sometimes you do have some reason for believing they will go in a particular direction. But the onus is on you to make that case. And if you can't make that case, you had better concentrate on the substitution effects.

(This post was inspired by Adam P.'s last three posts. I'm just drawing out a common theme from his critiques.)

Comments

[Frances Woolley]

As always, I'm impressed by the clarity and precision of your thinking.

But I'm not sure about your conclusion: "And if you can't make that case, you had better concentrate on the substitution effects."

Concentrating on the substitution effects can cause people to make the wrong macro predictions. Consider, for example, the effect of a reduction of taxes on investment income on the aggregate level of savings. The substitution effect says: lower taxes mean saving is cheaper so people save more. The income effect says: lower taxes mean people have more income therefore can afford to consume more today, and don't have to save as much to achieve an adequate standard of living in retirement. (Trying to get out of my automatic habit of thinking at the macro level, I could add: taxes on savings down implies relative taxes on earnings up implies people substitute towards leisure - or maybe they don't if the income effects predominate - or perhaps it means government debt up?). *We don't know how big the income effect is and, yes, it does matter from a macro point of view.*

When considering *welfare analysis* i.e. efficiency effects, yes, it's generally accepted that only substitution effects matter. And I should save your post to explain to my students why this is the case, as I can never work out a way of explaining that clearly.

But for predicting behaviour, no, I don't agree that the best guess is zero. It may be better to be approximately right than precisely wrong.

[Nick Rowe]

Thanks Frances!

What your point on taxes is really about is Ricardian Equivalence. Ricardian equivalence says that people internalise the government budget constraint. So a change in current taxes has zero direct effect on wealth (i.e. no "income" effect). A current tax increase just implies a future tax decrease. (Or an increase in the goods that the government buys for us, which get delivered to us as income in kind). Any effect on demand is really just a distribution effect (plus the substitution effect of course) if the government spends its income differently from the way the private sector does. And the distribution effect of intergenerational taxation is one example where we do have reasons for believing it will go in one direction rather than the other, and so Ricardian Equivalence would be false.

[Jon]

It merely redistributes income from buyers to sellers.

Nice. I note though that if the elasticities don't change, the income doesn't redistribute between buyer and seller. The substitution occurs between two different markets, not between the buyer and the seller in the market for apples per se.

[Frances Woolley]

Nick, no, I was definitely thinking about a world without Ricardian equivalence - but even without Ricardian equivalence, governments have budget constraints, so a cut in, say, revenues from taxation of investment income will affect expenditures, other taxes, or the debt.

[RSJ]

"At the aggregate level, there are no income effects of changes in prices, interest rates, wages, etc. There are only distribution effects. And substitution effects."

You are assuming that the economy is operating at full output, and that there are no "wasted" resources or slack anywhere, right? If the economy is not operating at full output, then there are pure income effects even at the aggregate level. And the point of economics, or a large portion of economics, should be devoted to explaining why the economy is so often not at full output, and why the output gap can be so large.

Moreover, your argument seems (to me) like an enormous aggregation fallacy. We can say:

1) Individual actors are subject to both income and substitution effects
2) Assuming the economy is at full output, then aggregate income is pre-determined.

And (it seems to me) that you are *assuming* that 1) +2) implies that the (individual) income effects cancel out at the macro level, and only the (individual) substitution effects remain.

But there is no reason to believe this. Saying "stuff bought" = "stuff sold" is not an argument that economy-wide substitution effects are independent of each individual's income effects, or that individual's income effects cancel out.

They don't cancel out at all.

[Nick Rowe]

RSJ: "You are assuming that the economy is operating at full output, and that there are no "wasted" resources or slack anywhere, right?"

Wrong. I am certainly not assuming that. My assumption is that quantity of apples bought = quantity of apples sold. And it most certainly is equal, everywhere. And that is not the same as saying "quantity of apples demanded = quantity of apples supplied" (which is only true in equilibrium). My point is pure accounting. (And I really wish that those economists who put so much emphasis on accounting actually understood this point. See Adam P..)

[Nick Rowe]

(Just to be clear in the above: I meant see Adam P.'s critiques of such economists, not that Adam was wrong on this.)

[Nick Rowe]

Frances: I did misunderstand your comment. Sorry. Let me try again.

If you cut taxes on savings, and increase taxes on earnings, to hold the budget balanced at the existing level of savings and employment, then there should be no direct effect on people's disposable income. So I think there should be no income effect on labour supply or savings supply. Only substitution effects on both. Plus possible distribution effects. (Those substitution effects might improve the overall allocation of resources, which could have an indirect effect on income, of course).

"Trying to get out of my automatic habit of thinking at the macro level..." Did you mean "micro", by the way?

[JKH]

"What works for apples works for everything else. For every apple bought there's an apple sold. For every unit of GDP bought there's a unit of GDP sold. For every $1 borrowed there's $1 lent. For every hour of labour sold there's an hour of labour bought. At the aggregate level, there are no income effects of changes in prices, interest rates, wages, etc. There are only distribution effects."

Great news, Nick!

You're morphing into an accountant!

Double entry - debits equal credits - the law of counterparties.

Congratulations and Happy New Year.

[JKH]

More seriously, in addition to paying attention to the exact definition of supply and demand curves, it seems to me you have a corresponding definition of buyers and sellers that you haven't spent as much time emphasizing, have you? All of these things are ex ante contingent, as opposed to ex post factual accounts.

[RSJ]

Nick,

OK, in that case, how do you get from "purchases = expenditures" to "income does not matter" in the aggregate economy ?

You've said this several times, without defining what you mean by "income effects".

Perhaps if you defined it, then we could get to the bottom of it.

[Nick Rowe]

JKH: Yep, this is pure accounting ;-) Happy New Year!

RSJ: Economists typically decompose the effects of a price change into two components: an income effect; and a substitution effect.

Suppose I have $100 income, buy 10 apples at $1 each and 90 buns at $1 each. Now the price of apples rises to $2 each. I would now need an extra $10 income to be able to afford the same basket of 10 apples and 90 buns. So the increase in the price of apples has the same effect on my real income as a loss of $10 income. If my income goes down, I will (usually) buy fewer apples (and fewer buns too). That's the "income effect" of the price increase. In addition to that income effect, the relative price of apples to buns has doubled, so I would substitute out of apples (and into buns). That's the substitution effect.

Graphically, with buns on the horizontal axis and apples on the vertical, my budget line has swivelled inwards, rotating about a point on the horizontal axis. We decompose that rotation into: a parallel leftward shift (income effect); a pure swivel with the existing consumption point as axis (substitution effect, Slutsky version).

[Nick Rowe]

Here's Wikipedia on income and substitution effects: http://en.wikipedia.org/wiki/Consumer_choice

The only difference is that Wiki uses the Hicksian decomposition, not the Slutsky decomposition (they swivel the budget line around the old indifference curve, not around the old consumption point).

[Andy Harless]

"But it's a lot easier if you add it to the demand curve, because that way the supply curve doesn't depend on the seller's own preferences for consuming apples."

Shouldn't the supply curve depend on the seller's preference for consuming his own product? A worker supplies his time. If he prefers to consume more of that time himself in the form of leisure, doesn't that affect the supply curve? Would anyone ever describe an increased preference for leisure as an increase in labor demand? Why is it different for apples?

[Frances Woolley]

Nick: "then there should be no direct effect on people's disposable income."

But the premise of most tax reform discussions is that disposable income *does* change.

[Nick Rowe]

Andy: agreed. If we just talked about excess demand curves (or excess supply curves), then we add both sellers and buyers into one curve (the other "curve" is the vertical axis). And we would talk about the income effect and substitution effect on excess demand.

But there's a lot to be said for having two curves, if the underlying behaviour of one curve is very different from the underlying behaviour of the other.

For example, we usually have one curve being firms' behaviour, and the other curve being household's behaviour. In output markets the demander is the Utility-maximising household, and the supplier the profit-maximising firm. In the labour market, the supplier is the household and the demander typically a firm.

[Nick Rowe]

Frances: "But the premise of most tax reform discussions is that disposable income *does* change."

I think of that as an indirect effect. The substitution effect causes a change in the equilibrium, and that change in equilibrium causes a change in income. If there were no substitution effect, there would be no change increase in disposable income. For example, if all indifference curves were L-shaped (to rule out substitution effects, but leave income effects), none of those tax reforms would do any good.

[RSJ]

Nick,

OK, but it still seems (to me) that you are assuming that aggregate income is bolted down somehow, and this is the only possible rationale for saying that income effects do not exist at the aggregate level. Let me give an example:

You have land and apples, not bananas and apples. When land prices are going up, then people are not substituting away from apples and into land, because they do not purchase land by refraining from purchasing apples, but they purchase land with money freshly created by banks. The $1 spent on land does not come at the expense of $1 spent on apples. And in fact, you can have spillover effects -- e.g. households with pre-existing land sell some of it and spend more on apples. Households that are buying land do not refrain from purchasing apples as the land is bought on credit. So that as land prices go up and incomes increase, households purchase more, not fewer, apples.

Is this a substitution effect?
Is this scenario impossible under your "income effects don't exist hypothesis"?
Does this scenario violate the "stuff sold" = "stuff bought" rule?

[RSJ]

And I would add that if you respond "if more money is spent on apples, then the price of apples will rise so that real incomes do not increase", in which case I would respond by saying that you are assuming that there is no output gap, which was my original point, or alternately you are assuming horizontal demand curves.

Finally, even though households purchase land on credit (without refraining from purchasing apples), as they repay the debt, then they do need to refrain from purchasing apples.

So the assumption that credit does not affect demand is equivalent to the assumption that the investment income from realized gains on the sale of land is exactly offset by the (mandatory) savings of those who are repaying debt, so that there is no net contribution to demand. I.e. this is a fixed asset price assumption.

If you drop that assumption, then you get periods of time in which those who sell assets receive more investment income from the sale than those who are currently paying off debt, leading to a greater demand for apples.

And you get other periods of time in which those who sell assets receive less investment income from the sale than those who are paying off debt, leading to a reduction in the demand for apples.

It's difficult to describe the above dynamics a "substitution" effect -- it seems like a pure income effect to me.

[Nick Rowe]

RSJ:

1. You need to distinguish clearly between the effects of a change in the *level* of prices and the effects of changes in the *expected rate of change* of prices. They normally have opposite effects on quantity demanded.

2. When a price changes, people will want to change their quantities demanded and supplied. In other words, demand curves (typically) slope down and supply curves slope up. And we are asking *why* they slope down or up. And economists typically explain those slopes in terms of income effects and substitution effects. Now, if a change in price *does* cause people to change their quantities demanded or supplied, that will almost always change everything in the economy, where "everything" includes income, both at the individual and at the aggregate level. But that is not what we are talking about here. We are talking about *why* a change in price will cause a change in quantity demanded or supplied. We are not talking about the *consequences* of those changes in quantities demanded or supplied.

3. This is the question you should have asked:

"Suppose the good in question is not a consumer good like apples. Suppose instead it is an asset like land. Won't an increase in the price of land constitute an increase in people's wealth? So there is a wealth effect, plus a substitution effect?"

(Preamble: what microeconomists call "income effects" are essentially the same as what macroeconomists call "wealth effects". In the one-period model of simple consumer choice theory, wealth and income are the same. But income effects should really be called "wealth effects", or maybe "permanent income effects" in any intertemporal model.)

The short answer is "no". An increase in asset prices does not increase wealth. There is no wealth effect from increased asset prices. (Jaws drop, sounds of stunned incredulity, hysterical laughter, etc.) But that short answer is subject to qualifications.

Here is Willem Buiter on why an increase in house prices does not increase wealth (with qualifications):
http://blogs.ft.com/maverecon/2007/10/housing-wealth-html/

OK, that's houses, which are a consumer durable. What about a producer durable, like land?

Suppose land prices rise, holding annual rents constant. (I.e. there is a fall in the yield on land.) If I own land, and plan to sell it (say) next year, then my wealth is higher. I can afford to buy more stuff with the proceeds of the sale. My budget constraint shifts out. I can afford to buy more stuff either now, or in the future. There is a positive income (wealth) effect on my demand for stuff (including land). But the person who is planning to buy my land next year will see a fall in his wealth. His budget constraint shifts in. He can't afford to buy as much stuff (including land).

So, there is no income effect (wealth effect) from a change in the price of assets like land, just as there is no income effect from a change in the price of apples. When the price goes up, sellers of land/apples are richer, and buyers of land/apples are poorer. There is only a distribution effect.

Most important qualification: in an overlapping generations model, the buyers of assets may be unborn. So the negative wealth effect on their demand cannot affect today's demand functions. OLG models are one case where we *can* say something about distribution effects a priori.

Notice that the issues here are exactly parallel to standard arguments about Ricardian Equivalence. If the unborn will pay the future taxes, and there is no intergenerational bequest motive, then bonds are net wealth, and an increase in the price of assets will have a wealth/income effect.

[Nick Rowe]

By the way. there is one big exception to all I have said above. That's money. Money (the medium of exchange) is weird. Another possible exception is goods that are used for conspicuous consumption (like what Frances has been talking about). A change in the price of money or bling will have an income/wealth effect. But I don't want to go there in this post.

[Nick Rowe]

Also, assets that are held purely for the precautionary demand, in a world of uncertainty.

[steve]

IIRC, Sumner said supply and demand should only be taught at the graduate level. Maybe he was right.

Steve

[Nick Rowe]

Steve: but would that mean we have to teach DSGE in ECON1000? Aaaargh!

[Scott Sumner]

Nick, Thanks for doing this. It has always bugged me when people argue against supply-side tax cuts by suggesting that while the substitution effect would lead to more labor supplied, the income effect would lead to less labor supplied. As a first order approximation only the substitution effect matters for tax changes that are permanent (and this doesn't even depend on Ricardian equivalence holding.) And yet I see distinguished economists making this elementary error all the time.

[D. Watson]

As Sumner has said repeatedly, the problem is reasoning from a price change. We can't say anything without understanding why the price changed. The price rose, so we consume fewer apples and sell more of them ... but to whom??

You said -- It is simply not true to say that if the price of apples rises we can't afford to consume as many apples. That "we" ignores the seller of apples. If the "we" includes both buyers and sellers, then collectively we can afford to consume exactly the same amount of apples as before. --

That 'afford to consume' is interesting. It costs the producer $0 to consume her own apples (ignoring opportunity costs), so we can always 'afford to consume' everything.

t=0
Buyer has $100 and purchases 10 apples and 90 buns at $1 each.
Seller has $100 and 20 apples. She sells 10, eats 10, and buys 110 buns.
Total GDP = $10 in apples bought + $10 imputed from own-production + $200 in buns = $220

t=1, the government imposes a price floor of $2 per apple.
Buyer has $100 and purchases 8 apples at and 84 buns.
Seller has $100 and 20 apples, but can't sell as many apples at $2 as she would like. She eats the remaining 12 and buys 116 buns.
Total GDP for the same 200 buns and the same 20 apples = $16 in apples bought, $24 imputed from own-production + $200 in buns = $240

Now mind, I haven't figured out where these buns are coming from, so this is not a complete model. We see substitution effects, we see distribution effects, and there is $240 worth of income and production to divide between two people instead of $220.

How do I convince my students in clear language that the extra $20 isn't an income effect?

[RSJ]

"My budget constraint shifts out. I can afford to buy more stuff either now, or in the future. There is a positive income (wealth) effect on my demand for stuff (including land). But the person who is planning to buy my land next year will see a fall in his wealth. His budget constraint shifts in. He can't afford to buy as much stuff (including land)."

No -- capital transactions in and of themselves do not shift anyone's budget constraint, at all.

The recognition of gains or losses shifts budget constraints. If you buy a new car -- there is the saying that you lose $3,000 when you drive out of the dealer, because if you were to re-sell the car, you would lose that much. So when you buy the $30,000 car, you are not spending $30,000, you are spending $3,000.

Now I'm using a simple cash-basis accounting here, so the recognition of gains and losses occurs at the same point in time as the transaction. But you are using improper accounting if you believe that the person buying the house must have their budget constraint diminished by the same amount as the person selling the house.

Here is an simple example. Assume everyone purchases the house on credit, and let one period = 1 month.

A has a house that he bought on credit 100 periods ago for X. He sells the house to B for 2X.

At the time he sold the house, he still owed X (it was an interest-only loan). During that the intervening time, the market price of houses was rising, but A did not book that gain as income. If A spent any more money in that time period, then this would be a "wealth effect". When he finally does sell to B, he retires the old loan and books a gain of X. His income increases by X. Whatever his budget constraint was before, it is now X units higher.

Let's look at B's budget constraint.

B purchases the house on credit, so in the current period, the only money that he must pay on housing is the monthly payment. That means that while B's budget constraint increases by X (because he recognized the gain), A's budget total constraint does not change at all, but A has committed to making the monthly payment, so that his constraint on non-housing goods decreases exactly by the monthly payment amount.

Now in what cases is the number of households making payments exactly equal to the amount of households selling their house for a gain or a loss, so that the aggregate income effect for non-housing goods is zero? This is exactly the condition net borrowing = 0 so that for every dollar borrowed, there is one dollar in debts that were repaid. This could be because the seller only retired the old loan and had nothing left over, or it could be that the seller rolled over the proceeds of the loan into a new house purchase. But one way or another (in this example), the amount of money available to spend on all non-housing goods increases or decreases by the amount of net borrowing for housing.

If net borrowing = +Z, then the sum of budget constraints on non-housing goods shifts out by +Z.

If net borrowing = -Z, then the sum of budget constraints on non-housing goods shifts in by Z.

Only in the special case of no aggregate credit growth can you argue that there is no income effect.

And a similar argument can be applied to all assets, whether housing or not.

Historically, non-financial debts grow at a faster rate than GDP -- they are almost never constant. Every time net borrowing decreased (and historically this only happened during the great depression and in the current recession) -- the economy has an extremely painful time dealing with the resulting drag on demand, because this is a direct reduction in incomes available to spend on non-assets.

[RSJ]

And in regards to Buiter, of course if you define the value of a house to be the discounted stream of rents, and declare any other price change as a bubble, then the only benefit to households will be when the bubble is expanding, and there will be an offsetting cost when the bubble is contracting. I think that's all pretty obvious and non-controversial.

The issue is that almost no one values a house as a discounted stream of rents -- every homeowner I've known takes re-sale value into account, and most people purchase a house expecting some price appreciation. Moreover, house prices are always increasing or decreasing faster than rental equivalents -- they are never in synch with rents. So again, unless your model bolts down asset prices via some form of rational valuation assumption -- which should immediately disqualify your model from having anything to say about recessions -- then you have to take take account of income effects at the macro level.

[D. Watson]

As Sumner has said repeatedly, the problem is reasoning from a price change. We can't say anything without understanding why the price changed. The price rose, so we consume fewer apples and sell more of them ... but to whom??

You said -- It is simply not true to say that if the price of apples rises we can't afford to consume as many apples. That "we" ignores the seller of apples. If the "we" includes both buyers and sellers, then collectively we can afford to consume exactly the same amount of apples as before. --

That 'afford to consume' is interesting. It costs the producer $0 to consume her own apples (ignoring opportunity costs), so we can always 'afford to consume' everything.

t=0
Buyer has $100 and purchases 10 apples and 90 buns at $1 each.
Seller has $100 and 20 apples. She sells 10, eats 10, and buys 110 buns.
Total GDP = $10 in apples bought + $10 imputed from own-production + $200 in buns = $220

t=1, the government imposes a price floor of $2 per apple.
Buyer has $100 and purchases 8 apples at and 84 buns.
Seller has $100 and 20 apples, but can't sell as many apples at $2 as she would like. She eats the remaining 12 and buys 116 buns.
Total GDP for the same 200 buns and the same 20 apples = $16 in apples bought, $24 imputed from own-production + $200 in buns = $240

Now mind, I haven't figured out where these buns are coming from, so this is not a complete model. We see substitution effects, we see distribution effects, and there is $240 worth of income and production to divide between two people instead of $220.

How do I convince my students in clear language that the extra $20 isn't an income effect?

[Adam P]

yep, Nick good post.

though you sort of stole my thunder mate :), I just finished my own post about this.

[Peter T]

Nick

1. "Who" MATTERS to people. It matters much more than almost anything else. So distribution matters.

2. Haven't you abstracted time? Producing stuff takes time and effort. The seller arrives at the market with a debt (in the apple producer's case, time and effort spent cultivating, picking, packing, transporting. Plus money spent on fertiliser, packaging etc). So the seller arrives with calculation about the expected price of apples, the gross and the net income. If he/she sells for less, the debt does not diminish, but the net income does. Surely this is what most people mean when they think of income effects?

Saying that the aggregate does not change is like saying that it doesn't matter if YOU lose your left leg, because some other creature has gained an equivalent amount of protein. It's true, but is it relevant?

[Panayotis]

It is amazing to me that economists are still confused with the difference between concepts such as aggregation of heterogeneous units,partial vs. general equilibrium analysis and intertemporal horizon and then they talk across purposes mixing their assumptions!Behavior is conditional to these concepts. As my teacher Milton Friedman used to say establish your assumptions clearly in order to win the argument as the logic then follows invariantly! By the way Bill M. was right given his assumptions of partial equilibrium, output gap, heterogeneous units, intertemporal reset of calculations along the supply curve, ex ante decisions vs. post practices etc.

[himaginary]

@D. Watson December 31, 2010 at 12:07 PM & 01:10 PM:

I suppose that the price level has risen, so the real GDP remains unchanged.

[himaginary]

RSJ@December 31, 2010 at 12:43 PM:"This is exactly the condition net borrowing = 0 so that for every dollar borrowed, there is one dollar in debts that were repaid."

I suppose if you incorporate time dimension in this condition, it results in what economists call transversality condition.

[anon]

From:

http://bilbo.economicoutlook.net/blog/?p=13025

"Aside – nasty monetarists or something

Someone brought to my attention how a North American blog (run by academic economists) had attacked me personally claiming that I have “less than zero understanding of “mainstream” macro”. The personal attacks were very vehement which is one thing.

They were attacking this blog – Money neutrality – another ideological contrivance by the conservatives.

First, the blogger writes under a nom de plume (that is, doesn’t tell you who s(he) is). I always think that is a fairly weak position and I always take personal responsibility for my writing and views. I don’t hide behind anonymity.

Second, if you check a range of standard (mainstream) macroeconomics text books (including the leading texts) that are used in undergraduate teaching then my rendition of the “mainstream” labour supply theory is very accurate and I was, in fact, very generous in my depiction. If I am wrong and my depiction is a “less than zero” representation then what are the major textbooks doing?

Third, I note the anonymous writer admitted to not even reading the above blog in its entirety. It is typical of the mainstream – to have pre-conceived (religious) positions and attack the alternatives without fully reading or learning about what the alternatives are.

The same WWW site exhibits an appalling understanding of the way monetary economies actually work and have promoted such erroneous concepts as the money multiplier to describe the way the banking operates.

Apparently, my claimed deficiencies relate to the way the topic is dealt with at the more advanced level. Yes, I could always present things at that level given my training but a blog is a blog and I have tens of thousands of readers each day most of who I suspect are not professionally trained macroeconomists (to their credit). In other words, I try to keep my blog as inclusive as possible.

I won’t link to the site because I suspect they get very little traffic and probably think that my inflaming me into a war of words I will send my daily audience there and give them a boost. My assessment is that their material is not worth reading. It is just the same old nonsense that academic departments deliver up to their brainwashed students every day of the year.

Sorry boys, I won’t bite."

[Nick Rowe]

Hmmm. I think Bill might have two blogs conflated. Some of what he say applies to this blog, but some of it clearly doesn't. For example, the 4 academic bloggers here are certainly not anonymous.

[anon]

its directed at one of your three inspirational links at the end of your post

[Nick Rowe]

Maybe, but "The same WWW site exhibits an appalling understanding of the way monetary economies actually work and have promoted such erroneous concepts as the money multiplier to describe the way the banking operates." sounds like me ;-).

[Adam P]

The same comments were posted on my blog but the statement "The same WWW site ...have promoted such erroneous concepts as the money multiplier to describe the way the banking operates" can't possibly be me.

I've never mentioned the money multiplier on my blog.

[anon]

:)

[Adam P]

Anyway, under the assumption he meant me I'll post a reply within a few days.

[Panayotis]

Adam P,

Of course he meant you! Read my comment. I am the one who informed him. Your usual assumptions of economic theory shows the dredam world you live in!

[Adam P]

Panyotis, then why did he lie about what I said? I've never once mentioned the money multiplier.

[Panayotis]

Adam P,

The issue is not the money multiplier. You have every right to accept a particular framework and defend it regarding its position on income effects. I objected on your personal attack on Bill M. However, please notice that,

1. Your hypothesis depends invariantly on its assumptions.
2. If the assumptions are not realistic then the hypothesis can be logical but not relevant.
I am sure you agree with the above even if we disagree on the relevance of GET.

[Adam P]

Well I didn't think I was attacking Bill M personally, I thought I was attacking what he said. There is a difference. The comments about not seeing what he could possibly have to say that's intelligent need to be taken in context. I'd have though it obvious that what I meant is that I struggle to see what he could have to say about the "mainstream" theory that's intelligent.

However, if his personality is an issue then so is his money multiplier comment, it's [wrong NR].

Furthermore, this statement of Bills:

" attack the alternatives without fully reading or learning about what the alternatives are."

is also completely without any basis in truth, please tell me at what point in my post did I attack his "alternative" ideas.

If the issue is Bill's personality I'm not sure he comes off that well to be honest, but my post wasn't supposed to be about that.

[Nick Rowe]

OK. I think Bill had me and Adam muddled on the money multiplier.

Panayotis: It's time to back off.

[Panayotis]

Nick Rowe,

no need to be rude.

adam P.,
Bill's personality is not the issue. Personal attacks are the issue which you seem to continue. your views are respected but based on unrealistic assumptions. period!